Initial Coin Offerings – A Viable Substitute for Venture Capital?

EDRIS DZULKIFLI
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February 21, 2019

You have a great business idea. You’ve done extensive research on product-market fit and put together a solid team with a shared vision. How about funding? As any business owner will tell you, cashflow can make or break your entrepreneurial dreams. Besides bootstrapping, wealthy parents and criminal activity, businesses often look to external investors or initial coin offerings to keep the funds flowing.

Up until recently, venture capital (VC) seemed to be the only option for startups and new businesses trying to find their feet. Then along came the cryptocurrency craze which brought about an alternate source of startup funding – the Initial Coin Offering (ICO). ICOs quickly gained momentum in 2017 and surpassed early-stage VC funding in June 2017.

As quickly as it skyrocketed, the cryptomarket soon came crashing down in November 2018, with digital currencies hitting their lowest levels ever. Prices have been hovering around the crash prices in November, and the craze that once took financial markets by storm has now faded.

During its heyday in early-2018, ICOs were THE go-to funding option. What made ICOs so appealing? What caused its eventual downfall? We take a look at the mechanics, the benefits, misconceptions of Initial Coin Offerings and how it compares to VC funding.

What is an ICO?

As its name suggests, Initial Coin Offerings draws similarities with Initial Public Offerings (IPO). However, instead of a public sale of shares in the case of the IPO, the ICO involves the public sale of digital tokens, also known as, cryptocurrency or cryptocoins. Here is a rundown of the ICO process from No Hat Digital:

If you’ve gone through the entire process, you will realise that there is no sale of company shares or equity. Companies that launch ICOs sell a promise that their business will become incredibly successful and the tokens will be used extensively. The fact that founders can retain full equity in their business makes ICOs a very attractive option for funding. Here are some other perceived benefits of ICO funding:

Investors can be anyone from anywhere around the world

A quick injection of funds without the hassle of due diligence

No requirement for a working product or business track record

Common ICO Misconceptions

2018 saw the eventual demise of ICO fundraising and cryptocurrencies. The dazzling excitement that was synonymous with ICOs in late-2017 has since dulled due to the wave of scams, government interventions and failed ICOs. The ebb and flow of cryptocurrencies actually lie with approximately 1,000 individuals who own 40% of the market, also known as institutional crypto-investors or crypto-whales. These whales were responsible for backing many ICOs through private rounds in mid-2018. Right now, fundraising through ICOs won’t generate as much capital, as the whales have gone into deep hibernation since their withdrawal from the markets in late-2018.

Creating a tech-based solution that presents a new use for digital tokens and blockchain technology is key to a successful cryptocurrency. Most companies that attempted to ride the ICO wave were just slapping digital tokens onto an existing business model where the tokens could be used interchangeably with money. Without an innovative utility, these tokens were merely a substitute for cash. This meant that the success of their business wasn’t tied directly to the use of the tokens on the platform, but the operating margins of their business, which provided no incentive for users to adopt their cryptocurrency.

While ICOs were considered to be a quick and simple solution to fundraising, traditional venture capital funding eventually came through as the most reliable avenue for investments.

Venture Capital Benefits

VC fundraising can be an arduous process. You will need to have a product, a decent track record, a detailed business roadmap, a captivating pitch presentation, multiple rounds of due diligence and term sheet negotiations. At the end of it all, you will have to dilute your shares in your own company to allow new stakeholders to influence the business. While the process is a lot more tedious, there is a wide range of benefits that come with the funds. Here are a few advantages of VC fundraising.

VCs have faith in your business, and will do whatever it takes to help you reach your goals, even if this means interrupting business meetings and leading discussions. VC investors are in it for the long haul, unlike the ICO investors that scrambled sell off digital tokens during the 2018 cryptocrash.

They Have Extensive Networks

Unlike the solitary speculators and cryptomarket watchers spiralling into isolated despair, VCs have incredibly intricate and extensive networks, and will introduce you to their ecosystem of business movers and shakers. This could come in the form of industry experts who can provide advice and guidance, or complementary businesses that could result in mutually beneficial partnerships.

Guidance and Mentorship

As your company starts to develop and grow, you will come across multiple stumbling blocks. Being experienced in diverse sets of businesses and organisations, VCs can spot these roadblocks easily. They can help you get in touch with the right people (thanks to their extensive networks), provide sound advice and guidance, and assist in hiring key positions to help you get back on track.

Initial Coin Offering or Venture Capital?

Now comes the question: should I raise funds through an ICO or pitch to VCs? It all depends on the needs of your business. If you are running a tech-based platform that requires (not just an additional feature) the use of digital tokens to access solutions, and you need a quick injection of funds without giving up equity, might want to consider an ICO.However, if you don’t like taking risks, and are looking for an experienced mentor to guide you through your business journey through their invaluable networks, VC fundraising is the solution for you. These are just 2 options among an entire listof possible sources of funding. Understand your business needs and goals before deciding to try your luck with digital tokens or to stick with the tried and tested VCs.